**FORM 10-QSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

| **(Mark  One)** |
|-----------------|
|            |   |
| **ý**      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|            |   |
|            | **For the quarterly period  ended September 30, 2004** |
|            |   |
|            | **OR** |
|            |   |
| **o**           | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|            |   |
|            | **For the transition period  from               to** |

 

**Commission file number 0-19777**

 

**DUSA Pharmaceuticals, Inc.**

(Exact name of registrant as specified in its charter)

 

| **New Jersey**                  |   | **22-3103129**      |
|---------------------------------|--------|---------------------|
| (State or other jurisdiction of |   | (I.R.S. Employer    |
| incorporation or organization)  |   | Identification No.) |

 

**25 Upton Drive**

**Wilmington, Massachusetts 01887**

(Address of principal executive offices)

(Zip Code)

 

**(978) 657-7500**

(Registrant’s telephone number, including area code)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 month (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filing requirements forthe past 90 days.

 
|   |   |   |   | Yes  ý | No  o |   |   |   |   |
|--------|--------|--------|--------|-----------------------|-----------------|--------|--------|--------|--------|

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

Indicate bycheck mark whether the registrant has filed all documents and reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934subsequent to the distribution of securities under a plan confirmed by a court.

 
|   |   |   |   | Yes  o | No  o |   |   |   |   |
|--------|--------|--------|--------|------------------|-----------------|--------|--------|--------|--------|

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 

16,870,072 shares as of November 9, 2004

 

 

----

 

**PART I.**

 

**ITEM 1.UNAUDITED FINANCIAL STATEMENTS**

 

**DUSAPHARMACEUTICALS, INC.**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **September 30,  2004** | ** **  | **December 31,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **(Unaudited)**         | ** **  | ** **             | ** ** |
| ** **                                                                                                                                                                                                                                                                                             | ** ** | ** **              | ** **  | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                             | ** ** | ** **              | ** **  | ** **             | ** ** |
| **Current  Assets**                                                                                                                                                                                                                                                                                    |       |                    |        |                   |       |
| Cash and  cash equivalents                                                                                                                                                                                                                                                                             |       | $                       | 10,493,350  |                   | $          | 4,294,482 |   |
| Marketable securities  available for sale                                                                                                                                                                                                                                                              |       | 41,912,004              |        | 30,284,841             |       |
| Accrued  interest receivable                                                                                                                                                                                                                                                                           |       | 468,268                 |        | 533,796                |       |
| Accounts  receivable                                                                                                                                                                                                                                                                                   |       | 391,733                 |        | 229,483                |       |
| Inventory                                                                                                                                                                                                                                                                                              |       | 1,381,444               |        | 712,831                |       |
| Prepaids and  other current assets                                                                                                                                                                                                                                                                     |       | 1,719,113               |        | 1,000,413              |       |
| **Total  current assets**                                                                                                                                                                                                                                                                              |       | 56,365,912              |        | 37,055,846             |       |
| Restricted  cash                                                                                                                                                                                                                                                                                       |       | 140,221                 |        | 139,213                |       |
| United  States government securities                                                                                                                                                                                                                                                                   |       | —                  |        | 3,250,940              |       |
| Property and  equipment, net                                                                                                                                                                                                                                                                           |       | 3,568,262               |        | 4,251,489              |       |
| **TOTAL  ASSETS**                                                                                                                                                                                                                                                                                      |       | $                       | 60,074,395  |                   | $          | 44,697,488 |   |
|                                                                                                                                                                                                                                                                                                   |       |                    |        |                   |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                                                         |       |                    |        |                   |       |
|                                                                                                                                                                                                                                                                                                   |       |                    |        |                   |       |
| **Current  Liabilities**                                                                                                                                                                                                                                                                               |       |                    |        |                   |       |
| Accounts  payable                                                                                                                                                                                                                                                                                      |       | $                       | 115,517     |                   | $          | 859,282 |   |
| Accrued  payroll                                                                                                                                                                                                                                                                                       |       | 842,125                 |        | 796,618                |       |
| Other  accrued expenses                                                                                                                                                                                                                                                                                |       | 1,787,856               |        | 1,162,139              |       |
| Current  maturities of long-term debt                                                                                                                                                                                                                                                                  |       | —                  |        | 270,000                |       |
| Deferred  revenue                                                                                                                                                                                                                                                                                      |       | 294,432                 |        | 129,900                |       |
| **Total  current liabilities**                                                                                                                                                                                                                                                                         |       | 3,039,930               |        | 3,217,939              |       |
| Long-term  debt, net of current maturities                                                                                                                                                                                                                                                             |       | —                  |        | 1,247,500              |       |
| **TOTAL  LIABILITIES**                                                                                                                                                                                                                                                                                 |       | $                       | 3,039,930   |                   | $          | 4,465,439 |   |
| ** **                                                                                                                                                                                                                                                                                             |       |                    |        |                   |       |
| **Commitments  and Contingencies (Note 10)**                                                                                                                                                                                                                                                           |       |                    |        |                   |       |
| ** **                                                                                                                                                                                                                                                                                             |       |                    |        |                   |       |
| **Shareholders’  Equity**                                                                                                                                                                                                                                                                         |       |                    |        |                   |       |
| Capital  Stock  Authorized:  100,000,000 shares; 40,000,000 shares designated as common stock, no par, and  60,000,000 shares issuable in series or classes; and 40,000 junior Series A  preferred shares. Issued and outstanding: 16,866,322 (2003: 13,966,247)  shares of common stock, no par. |       | $                       | 124,652,171 |                   | $          | 95,670,554 |   |
| Additional  paid-in capital                                                                                                                                                                                                                                                                            |       | 2,256,339               |        | 2,015,586              |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                                   |       | (70,482,514             | )           | (58,909,781            | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                                                                                                |       | 608,469                 |        | 1,455,690              |       |
| **TOTAL  SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                   |       | 57,034,465              |        | 40,232,049             |       |
| ** **                                                                                                                                                                                                                                                                                             |       |                    |        |                   |       |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                                                   |       | $                       | 60,074,395  |                   | $          | 44,697,488 |   |

 

See the accompanyingNotes to the Condensed Consolidated Financial Statements.

 

2

----

 

**DUSAPHARMACEUTICALS, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                | ** ** | **(Unaudited)**                       | ** ** | **(Unaudited)**                      | ** ** |
| **REVENUES**                                              |       |                                  |       |                                 |       |   |   |   |   |
| Product  sales                                            |       | $                                     | 2,010,619  |                                 | $          | 163,155 |   | $ | 5,442,332 |   | $ | 453,800 |   |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |
| **OPERATING  COSTS**                                      |       |                                  |       |                                 |       |   |   |   |   |
| Cost of  product sales and royalties                      |       | 718,168                               |       | 887,336                              |       | 2,612,884 |   | 2,464,667 |   |
| Research and  development                                 |       | 1,585,099                             |       | 1,202,130                            |       | 4,850,159 |   | 4,167,121 |   |
| Marketing  and sales                                      |       | 1,835,210                             |       | 535,114                              |       | 4,901,813 |   | 1,598,604 |   |
| General and  administrative                               |       | 1,197,707                             |       | 1,627,364                            |       | 5,775,500 |   | 4,782,385 |   |
| **TOTAL  OPERATING COSTS**                                |       | 5,336,184                             |       | 4,251,944                            |       | 18,140,356 |   | 13,012,777 |   |
| **LOSS  FROM OPERATIONS**                                 |       | (3,325,565                            | )          | (4,088,789                           | )          | (12,698,024 | ) | (12,558,977 | ) |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |
| **OTHER  INCOME**                                         |       |                                  |       |                                 |       |   |   |   |   |
| Interest  income, net                                     |       | 350,573                               |       | 408,931                              |       | 1,125,291 |   | 1,502,030 |   |
| **NET LOSS**                                              |       | $                                     | (2,974,992 | )                                    | $          | (3,679,858 | ) | $ | (11,572,733 | ) | $ | (11,056,947 | ) |
| **BASIC  AND DILUTED NET LOSS PER COMMON SHARE**          |       | $                                     | (0.18      | )                                    | $          | (0.26 | ) | $ | (0.72 | ) | $ | (0.79 | ) |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |
| **WEIGHTED  AVERAGE NUMBER OF COMMON SHARES OUTSTANDING** |       | 16,855,504                            |       | 13,954,450                           |       | 16,131,017 |   | 13,926,690 |   |

 

See the accompanyingNotes to the Condensed Consolidated Financial Statements.

 

3

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**DUSAPHARMACEUTICALS, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                             | ** ** | **Nine Months Ended September 30,** | ** **  |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------|-------------|
| ** **                                                                                             | ** ** | **2004**                            | ** **  | **2003** | ** ** |
| ** **                                                                                             | ** ** | **(Unaudited)**                     | ** **  | **(Unaudited)** | ** ** |
| **CASH  FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES**                                             |       |                                |        |   |   |
| Net loss                                                                                               |       | $                                   | (11,572,733 | ) | $ | (11,056,947 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities                            |       |                                |        |   |   |
| Amortization  of premiums and accretion of discounts on marketable securities available for  sale, net |       | 93,582                              |        | 72,181 |   |
| Depreciation  and amortization expense                                                                 |       | 1,190,605                           |        | 1,077,083 |   |
| Issuance of  common stock to consultants                                                               |       | 240,753                             |        | 110,000 |   |
| Changes in  other assets and liabilities impacting cash flows from operations:                         |       |                                |        |   |   |
| Restricted  cash                                                                                       |       | (1,008                              | )           | (1,014 | ) |
| Accrued  interest receivable                                                                           |       | 65,528                              |        | 264,759 |   |
| Accounts  receivable                                                                                   |       | (162,250                            | )           | (58,666 | ) |
| Inventory                                                                                              |       | (668,613                            | )           | 235,498 |   |
| Prepaids and  other current assets                                                                     |       | (718,700                            | )           | 348,748 |   |
| Accounts  payable                                                                                      |       | (743,765                            | )           | (23,125 | ) |
| Accrued  payroll and other accrued expenses                                                            |       | 671,224                             |        | (865,354 | ) |
| Deferred  revenue                                                                                      |       | 164,532                             |        | 47,940 |   |
| **Net cash  used in operating activities**                                                             |       | (11,440,845                         | )           | (9,848,897 | ) |
|                                                                                                   |       |                                |        |   |   |
| **CASH  FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES**                                             |       |                                |        |   |   |
| Purchases of  marketable securities                                                                    |       | (30,767,026                         | )           | (4,000,000 | ) |
| Proceeds  from maturing marketable securities                                                          |       | 21,450,000                          |        | 11,000,000 |   |
| Purchases of  property and equipment                                                                   |       | (507,378                            | )           | (399,667 | ) |
| **Net cash  provided by (used in) investing activities**                                               |       | (9,824,404                          | )           | 6,600,333 |   |
|                                                                                                   |       |                                |        |   |   |
| **CASH  FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES**                                             |       |                                |        |   |   |
| Issuance of  common stock                                                                              |       | 28,462,500                          |        | — |   |
| Stock  offering costs                                                                                  |       | (200,202                            | )           | — |   |
| Payments of  long-term debt                                                                            |       | (1,517,500                          | )           | (202,500 | ) |
| Proceeds  from exercise of options                                                                     |       | 719,319                             |        | 29,000 |   |
| **Net cash  provided by (used in) financing activities**                                               |       | 27,464,117                          |        | (173,500 | ) |
| **NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS**                                              |       | 6,198,868                           |        | (3,422,064 | ) |
| **CASH AND  CASH EQUIVALENTS AT BEGINNING OF PERIOD**                                                  |       | 4,294,482                           |        | 6,925,699 |   |
| **CASH AND  CASH EQUIVALENTS AT END OF PERIOD**                                                        |       | $                                   | 10,493,350  |   | $ | 3,503,635 |   |

 

**Non-Cash Transaction**

During 2004, the Company issued155,250 shares of its common stock in a private placement at $11.00 per shareas commission and non-refundable retainer to the placement agent for a totalvalue of $1,707,750 (See Note 6.)

 

See the accompanyingNotes to the Condensed Consolidated Financial Statements.

 

4

----

 

**DUSAPHARMACEUTICALS, INC.**

**NOTES TO THE CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**1)****                                     BASISOF PRESENTATION**

 

The Condensed Consolidated Balance Sheet as ofSeptember 30, 2004, Condensed Consolidated Statements of Operations for thethree and nine months ended September 30, 2004 and 2003, and CondensedConsolidated Statements of Cash Flows for the nine months ended September 30,2004 and 2003 of DUSA Pharmaceuticals, Inc. (the “Company” or “DUSA”) have beenprepared in accordance with accounting principles generally accepted in theUnited States of America.  Thesecondensed consolidated financial statements are unaudited but include allnormal recurring adjustments, which management of the Company believes to benecessary for fair presentation of the periods presented.  The results of the Company’s operations forany interim period are not necessarily indicative of the results of theCompany’s operations for any other interim period or for a full year.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted.  These condensed consolidated financialstatements should be read in conjunction with the Company’s December 31, 2003audited consolidated financial statements and notes thereto.  Certain amounts for 2003 have beenreclassified to conform to the current year presentation.  Such reclassifications had no impact on thenet loss or shareholders’ equity for any period presented.

 

**2)****                                     MARKETABLESECURITIES AVAILABLE FOR SALE**

 

The Company’s investment securities consist ofsecurities of the United States government and its agencies, and investmentgrade corporate bonds, all classified as available for sale.  Current yields, as of September 30, 2004,range from 1.25% to 7.63% and maturity dates range from October 15, 2004 toFebruary 15, 2007.  In August 2004, theCompany commenced investing in investment grade corporate securities, inaccordance with the Company’s investment policy. The estimated fair value andcost of marketable securities at September 30, 2004 and December 31, 2003are as follows: 
| ** **                                      | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **Fair Value**         | ** ** | **Cost**              | ** ** | **Fair Value** | ** ** | **Cost** | ** ** |
| ** **                                      | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
|                                            |       |                   |       |                  |       |   |   |   |   |
| United  States government securities            |       | $                      | 32,206,395 |                  | $          | 31,590,499 |   | $ | 33,535,781 |   | $ | 32,080,091 |   |
| Investment  grade corporate securities          |       | 9,705,609              |       | 9,713,036             |       | — |   | — |   |
| Total  marketable securities available for sale |       | $                      | 41,912,004 |                  | $          | 41,303,535 |   | $ | 33,535,781 |   | $ | 32,080,091 |   |

 

5

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**DUSAPHARMACEUTICALS, INC.**

**NOTES TO THE CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

** **

**3)****                                     INVENTORY**

 

Inventoryconsisted of the following:

 
| ** **      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------|------------|-------------------------|------------|------------------------|------------|
| ** **      | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| Finished  goods | ** ** | $                       | 1,003,172  |                   | $          | 582,382 |   |
| Work in process |       | 262,138                 |       | —                 |       |
| Raw materials   |       | 116,134                 |       | 130,449                |       |
|            |       | $                       | 1,381,444  |                   | $          | 712,831 |   |

 

**4)****                                     OTHERACCRUED EXPENSES**

 

Other accruedexpenses consisted of the following:

 
| ** **                        | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                        | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| Research and development costs    |       | $                       | 234,780    |                   | $          | 184,912 |   |
| Marketing and sales costs         |       | 95,497                  |       | 113,020                |       |
| Product related costs             |       | 478,112                 |       | 144,826                |       |
| Legal and other professional fees |       | 515,123                 |       | 359,747                |       |
| Employee benefits                 |       | 217,472                 |       | 189,051                |       |
| Other expenses                    |       | 246,872                 |       | 170,583                |       |
|                              |       | $                       | 1,787,856  |                   | $          | 1,162,139 |   |

 

**5)****                                     LONG-TERMDEBT**

 

In May 2002,DUSA entered into a secured term loan promissory note (“Note”) with CitizensBank of Massachusetts to fund the construction of its manufacturing facilityand borrowed $1,900,000. DUSA repaid the outstanding loan balance in June 2004without premium or penalty. The security interest in approximately $3,000,000of the Company’s United States government securities that were pledged ascollateral to secure the loan was released.

 

6

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**DUSA PHARMACEUTICALS,INC.**

**NOTES TO THE CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**6)****                                     SHAREHOLDERS’EQUITY**

 

On February 27, 2004, the Company completed a private placement of 2,250,000 shares of its common stock at a purchase price of $11.00 per share, resulting in gross proceeds of $24,750,000. The closing date of the private placement was March 2, 2004. The Company also granted the investors the right to purchase up to an aggregate of an additional 337,500 shares of common stock at $11.00 per share. These additional investment rights were exercised on April 14, 2004, resulting in additional gross proceeds of $3,712,500.  Offering costs incurred in connection with the placement were $1,907,952, of which $1,707,750 consisted of the placement agent’s commission and non-refundable retainer paid in the form of 155,250 shares of common stock calculated at the offering price.

 

On March 18,2004, the Company granted a total of 30,000 fully vested options to threeconsultants on its Medical Advisory Board as compensation for services. Theseoptions were valued at $240,753 in accordance with the fair value-based methodas required by Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,“Accounting for Stock-Based Compensation, Transition and Disclosure,” andEmerging Issues Task Force (“EITF”) No. 96-18, “Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services,” and recorded as part of researchand development costs in the Condensed Consolidated Statement of Operations.

 

**7)****                                     ACCOUNTINGFOR STOCK BASED COMPENSATION**

 

SFAS No. 123,as amended by SFAS No. 148, addresses the financial accounting and reportingstandards for stock or other equity-based compensation arrangements. TheCompany has elected to continue to use the intrinsic value-based method toaccount for employee stock option awards under the provisions of AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees,”and to provide disclosures based on the fair value method as permitted by SFASNo. 123, as amended by SFAS No. 148. Under the intrinsic value method,compensation expense, if any, is recognized for the difference between theexercise price of the option and the fair value of the underlying common stockas of a measurement date. The measurement date is the time when both the numberof shares and the exercise price is known. Stock or other equity-basedcompensation for non-employees must be accounted for under the fair value-basedmethod as required by SFAS No. 123, as amended by SFAS No. 148, and EITF No.96-18, and other related interpretations. Under this method, the equity-basedinstrument is valued at either the fair value of the consideration received orthe equity instrument issued on the measurement date, which is generally thegrant date. The resulting compensation cost is recognized and charged tooperations over the service period, which is generally the vesting period.

 

7

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**DUSAPHARMACEUTICALS, INC.**

**NOTES TO THE CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

As describedabove, the Company uses the intrinsic value method to measure compensation expenseassociated with grants of stock options to employees. Had the Company used thefair value method to measure compensation, the Company’s pro forma net loss andpro forma net loss per common share for the three and nine months endingSeptember 30, 2004 and 2003 would have been as follows:

 
| ** **                                                                                                                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                |       | **(Unaudited)**                       |       | **(Unaudited)**                      |       |
|                                                                                                                                |       |                                  |       |                                 |       |   |   |   |   |
| **Net Loss**-** **As reported                                                                                                  |       | $                                     | (2,974,992 | )                                    | $          | (3,679,858 | ) | $ | (11,572,733 | ) | $ | (11,056,947 | ) |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method, net of related tax effects |       | (438,535                              | )          | (482,455                             | )          | (1,935,133 | ) | (1,613,376 | ) |
| **Net Loss**-** **Proforma                                                                                                     |       | $                                     | (3,413,527 | )                                    | $          | (4,162,313 | ) | $ | (13,507,866 | ) | $ | (12,670,323 | ) |
|                                                                                                                                |       |                                  |       |                                 |       |   |   |   |   |
| **Basic  and Diluted Net Loss Per Common Share**-** **As reported                                                              |       | $                                     | (0.18      | )                                    | $          | (0.26 | ) | $ | (0.72 | ) | $ | (0.79 | ) |
| **Basic  and Diluted Net Loss Per Common Share**-** **Proforma                                                                 |       | $                                     | (0.20      | )                                    | $          | (0.30 | ) | $ | (0.84 | ) | $ | (0.91 | ) |

 

**8)****                                     BASICAND DILUTED NET LOSS PER COMMON SHARE**

 

Basic net lossper common share is based on the weighted average number of shares outstandingduring each period. Stock options and warrants are not included in thecomputation of the weighted average number of shares outstanding for dilutivenet loss per common share during each of the periods presented in the CondensedConsolidated Statements of Operations, as the effect would be antidilutive. Forthe periods ended September 30, 2004 and 2003, such potentially dilutivesecurities totaling approximately 3,043,000 and 2,711,000 shares, respectively,have been excluded from the computation of diluted net loss per common share.

 

8

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**DUSAPHARMACEUTICALS, INC.**

**NOTES TO THE CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**9)****                                     COMPREHENSIVELOSS**

 

For the threeand nine months ended September 30, 2004 and 2003, comprehensive loss consistedof the following:

 
| ** **                                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                             | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                   |       | **(Unaudited)**                       |       | **(Unaudited)**                      |       |
|                                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| **NET LOSS**                                                                           |       | $                                     | (2,974,992 | )                                    | $          | (3,679,858 | ) | $ | (11,572,733 | ) | $ | (11,056,947 | ) |
| Change in net unrealized gains and losses  on marketable securities available for sale |       | (130,812                              | )          | (407,119                             | )          | (847,221 | ) | (774,450 | ) |
|                                                                                   |       |                                  |       |                                 |       |   |   |   |   |
| **COMPREHENSIVE  LOSS**                                                                |       | $                                     | (3,105,804 | )                                    | $          | (4,086,977 | ) | $ | (12,419,954 | ) | $ | (11,831,397 | ) |

 

Accumulatedother comprehensive income consists of net unrealized gains and losses onmarketable securities available for sale, which is reported as part ofshareholders’ equity in the Condensed Consolidated Balance Sheets.

 

**10)****                              COMMITMENTSAND CONTINGENCIES**

 

*LegalMatters*– On April 12, 2002, the Company receivednotice that one of the patents licensed to the Company by PARTEQ Research &Development Innovations, the technology transfer arm of Queen’s University atKingston, Ontario was being challenged by PhotoCure ASA. PhotoCure ASA filed alawsuit in Australia alleging that Australian Patent No. 624985, which is oneof the patents relating to the Company’s 5-aminolevulinic acid technology, wasinvalid.  As a consequence of thisaction, Queen’s University assigned the Australian patent to the Company sothat DUSA could participate directly in this litigation.  The Company filed a response setting forthits defenses, and a related countersuit alleging that certain activities ofPhotoCure and its marketing partner, Galderma S.A., infringe the patent. Thefinal hearing in the Federal Court of Australia was held in April 2004, and adecision is expected in late 2004 or early 2005.  Each party has the right to appeal withinapproximately one month following the Court’s decision. The Company is unableto predict the outcome of the case at this time.

 

In December2003, the Company was served with a complaint filed in the State of MichiganCircuit Court for the County of Oakland alleging that DUSA’s BLU-U®caused the plaintiff to suffer a seizure during the performance of her dutiesas an office assistant. The complaint names Berlex Laboratories, Inc., asubsidiary of the Company’s former marketing partner, as another defendant. Thecase has been removed to the U.S. District Court for the Eastern District ofMichigan Southern Division. The damages are unspecified. The Company has

 

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**DUSAPHARMACEUTICALS, INC.**

**NOTES TO THE CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

filed its answer denying theclaims, and Berlex has requested indemnification from the Company under theterms of the Company’s former agreement with Schering AG, Berlex’s parent.Currently, the Company has declined to indemnify Berlex. Recently the Courtentered an order allowing the Plaintiff’s attorney to withdraw. Plaintiff iscurrently acting on her own behalf. A Motion to Dismiss for No Progress isscheduled for hearing on November 22, 2004. While it is not possible to predictor determine the outcome of this action, the Company believes that the costsassociated with all such matters will not have a material adverse effect on itsconsolidated financial position or liquidity, but could possibly be material tothe consolidated results of operations in any one period to the extent costsare not covered by DUSA’s insurance.

 

**11)****                              THIRD-PARTYCANADIAN MARKETING AND DISTRIBUTION AGREEMENT**

 

**On March 31, 2004, DUSA signed an exclusive Canadianmarketing and distribution agreement for the Kerastick® and BLU-U®with Coherent-AMT Inc. (“Coherent”), a leading Canadian medical device andlaser distribution company.  Coherentbegan marketing the BLU-U® for moderate inflammatory acne in April2004 and the Kerastick® for the treatment of non-hyperkeratoticactinic keratoses, or AKs, in June 2004, following receipt of the applicableregulatory approval from Health Canada. The agreement has a three-year term, which can be automatically renewedfor additional one-year terms, unless either party notifies the other partyprior to a term expiration that it does not intend to renew the agreement.  In addition, during the initial three-yearterm, either party may terminate the agreement earlier by providing formalwritten notice of its intention to do so at least 90 days in advance of eachanniversary of the effective date, or in the event that the other party shallhave materially breached any of its obligations in the agreement.  DUSA recognizes product sales when Coherentsells the Kerastick® and the BLU-U® to the end-user, asthe price is fixed and final at that point.**

** **

**12)****                              AMENDEDAND RESTATED PURCHASE AND SUPPLY AGREEMENT**

 

**On June 21, 2004, DUSA signed an Amended and RestatedPurchase and Supply Agreement with National Biological Corporation (“NBC”), themanufacturer of its BLU-U® light source.  This agreement provides for the eliminationof certain exclusivity clauses, permits DUSA to order on a purchase order basiswithout minimums, and other modifications of the original agreement providingboth parties greater flexibility related to the development and manufacture oflight sources, and the associated technology within the field of PDT.  DUSA paid $110,000 to NBC upon execution ofthe agreement which will be amortized over the remaining term of the agreement,expiring November 5, 2008.**

 

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**ITEM 2.****                                                     MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

# **Overview**

 

**DUSA is a pharmaceutical company engaged primarily in theresearch, development, and marketing of a drug named 5-aminolevulinic acid, orALA, which is used in combination with appropriate light devices in order todetect or treat a variety of medical conditions.  The trademark for our brand of ALA is Levulan®.  When Levulan® is used and followedwith exposure to light to produce a therapeutic effect, the technology iscalled photodynamic therapy, or PDT. When Levulan® is used and followed with exposure to light todetect medical conditions, the technology is called photodetection, or PD.  Our products are Levulan® 20%topical solution using our Kerastick® brand applicator, and ourBLU-U® brand light unit.  Ourproducts are used together to provide PDT for the treatment ofnon-hyperkeratotic actinic keratoses, or AKs, of the face or scalp. Inaddition, the BLU-U® is used without Levulan® for thetreatment of moderate inflammatory acne vulgaris. Both products have receivedapproval or market clearance as required from the United States Food and DrugAdministration (“FDA”).**

** **

Marketing andsales activities since the October 2003 launch of our sales force have resultedin significant additional revenues and expenses. Kerastick® unitsales to end-users were 20,196 for the three months ended September 30, 2004,consisting of 18,870 sold in the United States (“U.S.”), and 1,326 sold byCoherent-AMT, our Canadian marketing and distribution partner.  To date, approximately ten percent oflicensed dermatologists in the U.S. have used our Kerastick®.  A summary of Kerastick® unit salesto end users during the periods ended September 30, 2004 and 2003 consisted ofthe following:

 

| **2004** | ** ** | ** ** | ** ** | **2003** | ** ** |
|----------|------------|------------|------------|----------|------------|
| **Q1**   | ** ** | **Q2**     | ** ** | **Q3**   | ** ** | **Total** | ** ** | ** ** | ** ** | **Q1** | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Total** | ** ** |
| 12,054   |       | 16,002     |       | 18,870   |       | 46,926 | ** ** | **U.S.** |   | 1,842 |   | 1,914 |   | 1,938 |   | 5,694 |   |
| —   |       | 1,908      |       | 1,326    |       | 3,234 | ** ** | **Canada** |   | — |   | — |   | — |   | — |   |
| 12,054   |       | 17,910     |       | 20,196   |       | 50,160 | ** ** | **Total** |   | 1,842 |   | 1,914 |   | 1,938 |   | 5,694 |   |

 

The net numberof BLU-U® units placed in doctors’ offices during the three monthsended September 30, 2004 was 95, including 25 placed in Canada.  As of September 30, 2004 there were 870 unitsin doctor’s offices, consisting of 784 in the U.S. and 86 in Canada. There were406 BLU-U units in doctors’ offices at December 31, 2003.

 

Although thecosts related to the addition of our sales force and related marketingactivities are significant as compared to the revenue generated from theincrease in sales, we are encouraged with the ongoing increases in sales. Wehave continued our efforts to penetrate the market by expanding our salescoverage in key geographic locations. As of September 30,2004, ourdirect sales force consisted of 22 representatives plus our Associate VicePresident of Sales. We expect to continue to incur operating losses until salesof our products increase substantially above the current levels. We do notintend to hire a significant number of additional sales personnel for thebalance of 2004, and we have replaced some of our independent representatives

 

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with full-time DUSArepresentatives.

 

At this time,our core objectives include focusing on increasing sales in the United States,conducting clinical trials to treat acne vulgaris and photodamaged skin, which,if successful, could lead to additional regulatory approvals. In addition, wecontinue to advance development of Levulan® PDT for the treatment ofdysplasia in patients with Barrett’s esophagus and support independentinvestigator trials to advance research in the use and applicability of Levulan®PDT for dermatology and internal indications. We have begun to examine the costs and procedures associated withseeking foreign regulatory approvals for our products, which could cause ouroperating cost budget to increase.  Weexpect that an important focus during 2005 will include seeking partnerships orother relationships for the marketing and sales of Levulan® PDToutside of the U.S. and Canada subject to appropriate regulatory approvals.

 

To further our objectivesconcerning treatment of Barrett’s esophagus and other internal indicationsusing Levulan®photodynamic therapy (“PDT”), on September 27, 2004 we signed a clinical trialagreement with the National Cancer Institute (“NCI”) Division Of Cancer Prevention(“DCP”) for the clinical development of Levulan® PDT for the treatment of high-grade dysplasia within Barrett’sEsophagus. In addition, on November 4, 2004 we signed an additional clinicaltrial agreement with the NCI DCP for the treatment of oral cavitydysplasia. DUSA and the NCI DCP will be workingtogether to prepare overall clinical development plans for Levulan® PDT in these indications, starting with Phase II BE trials, and PhaseI/II oral cavity trials, and continuing through Phase III studies ifappropriate. The immediate plan is for the NCI DCP to solicit clinicalprotocols from its extramural expert clinical investigator consortium, afterwhich time DUSA and the NCI DCP will finalize the clinical trial designs. TheNCI DCP will use its resources to file its own Investigational New Drug applications with the FDA. DUSA will provide Levulan®, device(s) and the necessary training for the investigators involved inthe studies. DUSA will maintain full ownership of its existing intellectualproperty, has options on new intellectual property and, subject to successfulclinical trial results, intends to seek FDA approvals in due course.

 

**On June 21, 2004, DUSA signed an Amended and RestatedPurchase and Supply Agreement with National Biological Corporation (“NBC”), themanufacturer of its BLU-U**® light source.  This agreementeliminated certain exclusivity clauses, permits DUSA to order on a purchaseorder basis without minimums, and made other modifications to the originalagreement providing both parties greater flexibility related to the developmentand manufacture of light sources, and the associated technology within thefield of PDT.   DUSA paid $110,000 to NBCupon execution of the agreement which will be amortized over the remaining termof the agreement, expiring November 5, 2008. The Company has ordered additionalBLU-U® units under theamended agreement and expects to be re-supplied during the first quarter of2005. We may experience an inventory backlog until the new supply of lightsources is available.  If a backlogoccurs, BLU-U® revenues would be negatively impacted and customerscould purchase devices from other manufacturers rather than simply delay apurchase of a BLU-U®. In addition, growth of Kerastick®sales could be adversely affected by limited BLU-U® sales, though webelieve this effect should not be significant.

 

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**On February 24, 2004, DUSA reacquired the rights to theaminolevulinic acid (Levulan®) technology for Canada held by DraxisHealth Inc. (“Draxis”), DUSA’s former parent. These rights were initiallyassigned to Draxis in 1991 at the time of the original licensing of the patentsunderlying our Levulan® PDT platform from PARTEQ Research andDevelopment Innovations, the licensing arm of Queen’s University, Kingston,Ontario. DUSA and Draxis terminated the assignment and DUSA agreed to pay toDraxis an upfront fee and an ongoing royalty on sales of the Levulan®Kerastick® in Canada over a five year term. In addition, on March 31,2004 DUSA signed an exclusive marketing and distribution agreement for Canadawith Coherent-AMT, a leading Canadian medical device and laser distributioncompany. Coherent-AMT began marketing the BLU-U® for moderateinflammatory acne upon entering our agreement and the Kerastick® inJune 2004 for the treatment of non-hyperkeratotic actinic keratoses, or AKs,following receipt of regulatory approval from Health Canada.**

 

In February2004, DUSA commenced commercial production of the Levulan® Kerastick®at its Wilmington, Massachusetts manufacturing facility. During the secondquarter, we commenced the distribution of the initial commercial productproduced at our manufacturing facility. Production has continued during thecurrent quarter based upon the anticipated demand for the Kerastick®.

 

On February 27, 2004, DUSA entered into definitive agreements withcertain institutional and other accredited investors for the private placementof 2,250,000 shares of its common stock at a purchase price of $11.00 per share,resulting in gross proceeds to DUSA of $24,750,000. The closing date of theprivate placement was March 2, 2004. DUSA also issued additional investmentrights providing the investors with the right to purchase up to an aggregate ofan additional 337,500 shares of common stock at $11.00 per share. All of theadditional investment rights were exercised on April 14, 2004. Offering costsincurred in connection with the placement were $1,908,000, of which $1,708,000consisted of the placement agent’s commission and non-refundable retainer paidin the form of 155,250 shares of common stock calculated at the offering price.DUSA will use the proceeds from the sale of the securities to expand its salesforce and for general working capital purposes, including research anddevelopment activities.

 

**DUSA has devoted its resources primarily to fund researchand development in order to advance the Levulan® PDT/PD technologyplatform and, as a result, we have experienced significant operatinglosses.  As of September 30, 2004, we hadan accumulated deficit of approximately $70,483,000. Achieving our goal ofbecoming a profitable operating company is dependent upon acceptance of ourtherapy by the medical and consumer constituencies and our ability to developnew products.**

** **

DUSA hascontinued to support efforts to improve reimbursement levels to physicians.Some physicians have suggested that current reimbursement levels still do notfully reflect the required efforts to routinely employ our therapy in theirpractices. We believe that this issue has adversely affected the economiccompetitiveness of our products with other AK therapies and has hindered theadoption of our therapy. However, we continue to work to improve reimbursementlevels. We have also educated the major private insurance carriers about our AK

 

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therapy, and several majorprivate insurers have approved coverage. We believe that due to these efforts,along with our education and marketing programs, and increased interest inother uses for our products, more widespread adoption by the medical communitywill occur over time.

 

We have beenencouraged by the positive response from many physicians and patients who haveused our therapy, but we recognize that we have to continue to demonstrate theclinical value of our unique therapy, and the related product benefits ascompared to other well-established conventional therapies, in order for themedical community to accept our products on a large scale. While our financialposition is strong, we cannot predict when product sales may offset the costsassociated with these efforts. We are aware that some physicians have beenusing Levulan® with the BLU-U®, and with light devicesmanufactured by other companies, for uses other than our FDA-approved use.While we are not permitted to market our products for so-called ‘off-label’uses, these activities are positively affecting the sales of our products.

 

As ofSeptember 30, 2004, DUSA’s staff included 66 full-time employees and 2part-time employees as compared to 50 full-time employees and 1 part-timeemployee at the end of 2003. These include marketing and sales, production,maintenance, customer support, and financial operations personnel, as well asthose who support research and development programs for dermatology andinternal indications. We expect to continue to increase our staff during theremainder of 2004 and into 2005 as we focus on sales, marketing activities andcustomer support associated with our AK products, research and developmentprograms for dermatology and internal indications, and other support functions.

 

**Critical Accounting Policies**

 

Our accountingpolicies are disclosed in Note 2 to the Notes to the Consolidated FinancialStatements in our Annual Report on Form 10-K for the year ended December 31,2003.  Since all of these accountingpolicies do not require management to make difficult, subjective or complexjudgments or estimates, they are not all considered critical accountingpolicies.  We have discussed thesepolicies and the underlying estimates used in applying these accountingpolicies with our audit committee.  Weconsider the following policies and estimates to be critical to our financialstatements.

 

***Revenue Recognition*****– Revenues on product sales are recognized when persuasiveevidence of an arrangement exists, the price is fixed and final, delivery hasoccurred, and there is reasonableness of collection.  Product sales made through distributors whohave a general right of return of product have been recorded as deferredrevenue until the product is sold by our distributors to the end user. Althoughwe make every effort to assure the reasonableness of our estimates, significantunanticipated changes in our estimates due to business, economic, or industryevents could have a material impact on our results of operations.

 

***Inventory*****–**Inventoriesare stated at the lower of cost or market. Cost is determined using the first-in, first-out method.  Inventories are continually reviewed for slowmoving, obsolete or excess items. Inventory items identified as slow-moving are evaluated to determine

 

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if an adjustment is required.  Additionally, our industry is characterizedby regular technological developments that could result in obsoleteinventory.  Although we make every effortto assure the reasonableness of our estimates, any significant unanticipatedchanges in demand, technological development, or significant changes to ourbusiness model could have a significant impact on the value of our inventoryand our results of operations. We use sales projections to estimate theappropriate level of inventory that should remain on the Condensed ConsolidatedBalance Sheet.  Management believes thatthe level of remaining Kerastick® inventory is reasonable in lightof our current sales forecasts.

 

***Valuation of Long-lived andIntangible Assets*** – We review long-lived assets forimpairment whenever events or changes in business circumstances indicate that thecarrying amount of assets may not be fully recoverable or that the useful livesof these assets are no longer appropriate. Factors considered important which could trigger an impairment reviewinclude significant changes relative to: (i) projected future operatingresults; (ii) the use of the assets or the strategy for the overall business;(iii) business collaborations; and (iv) industry, business, or economic trendsand developments.  Each impairment testis based on a comparison of the undiscounted cash flow to the recorded value ofthe asset.  If it is determined that thecarrying value of long-lived or intangible assets may not be recoverable basedupon the existence of one or more of the above indicators of impairment, theasset is written down to its estimated fair value on a discounted cash flowbasis.  At September 30, 2004, our totalproperty, plant and equipment had a carrying value of $3,568,000, including$2,007,000 associated with our manufacturing facility, which received FDAapproval in July 2003 and began inventory production in February 2004. We hadno intangible assets recorded as of September 30, 2004 and December 31, 2003.

 

***Stock-based Compensation***– We have elected to continue to use the intrinsic value-based method toaccount for employee stock option awards under the provisions of AccountingPrinciples Board Opinion No. 25, and to provide disclosures based on the fairvalue method as permitted by Statement of Financial Accounting Standards(“SFAS”) No. 123, “Accounting for Stock Compensation,” as amended by SFAS No.148, “Accounting for Stock-Based Compensation, Transition and Disclosure”.  Stock or other equity-based compensation fornon-employees is accounted for under the fair value-based method as required bySFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, “Accounting forEquity Instruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services” and other related interpretations.Under this method, the equity-based instrument is valued at either the fairvalue of the consideration received or the equity instrument issued on the dateof grant.  The resulting compensationcost is recognized and charged to operations over the service period, which, inthe case of stock options, is generally the vesting period.  As we utilize stock and stock options as onemeans of compensating employees, consultants, and others, a change inaccounting for stock-based compensation could, under certain circumstances,result in an adverse material effect on our results of operations, but wouldnot affect cash flows.

 

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**Results of Operations**

 

***Revenues –***Total revenues for the three and nine months ended September 30, 2004 were$2,011,000 and $5,442,000, respectively, as compared to $163,000 and $454,000in the same periods in 2003, and were comprised of the following:

 
| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                              | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                    |       | **(Unaudited)**                       |       | **(Unaudited)**                      |       |
|                                    |       |                                  |       |                                 |       |   |   |   |   |
| **Kerastick® sales to physicians** |       |                                  |       |                                 |       |   |   |   |   |
| U.S.                                    |       | $                                     | 1,414,000  |                                 | $          | 163,000 |   | $ | 3,513,000 |   | $ | 454,000 |   |
| Canada                                  |       | 85,000                                |       | —                               |       | 185,000 |   | — |   |
| Total                                   |       | $                                     | 1,499,000  |                                 | $          | 163,000 |   | $ | 3,698,000 |   | $ | 454,000 |   |
|                                    |       |                                  |       |                                 |       |   |   |   |   |
| **BLU-U® sales to physicians**     |       |                                  |       |                                 |       |   |   |   |   |
| U.S.                                    |       | $                                     | 432,000    |                                 | $          | — |   | $ | 1,481,000 |   | $ | — |   |
| Canada                                  |       | 80,000                                |       | —                               |       | 263,000 |   | — |   |
| Total                                   |       | $                                     | 512,000    |                                 | $          | — |   | $ | 1,744,000 |   | $ | — |   |
|                                    |       |                                  |       |                                 |       |   |   |   |   |
| Total  product sales                    |       | $                                     | 2,011,000  |                                 | $          | 163,000 |   | $ | 5,442,000 |   | $ | 454,000 |   |

 

**The increase in 2004 product sales reflects sales tophysicians for the three and nine months ended September 30, 2004 of 20,196 and50,160 Kerastick® units, respectively, as compared to 1,938 and5,694**Kerastick®units for the 2003 periods.  The increasein product revenues also reflects an increase in the BLU-U® units inplace in physician’s offices of 870 units as of September 30, 2004, up from 406units at December 31, 2003. With respect to Kerastick sales, we have increasedour direct selling effort, while still maintaining the services of onedistributor.  We expect that in the nearfuture we will bring a significant level of the distribution function in-housewhich will increase our gross revenue per unit recognizing that we will have increasedcosts to support this function.

 

**On March 31, 2004, DUSA signed an exclusive marketing anddistribution agreement for the Kerastick® and BLU-U® inCanada with Coherent-AMT Inc. (“Coherent”), a leading Canadian medical deviceand laser distribution company. Following receipt of regulatory approval from Health Canada, Coherentbegan marketing the BLU-U® for moderate inflammatory acne in April2004, and the Kerastick® for the PDT treatment of non-hyperkeratoticactinic keratoses, or AKs, in June 2004. DUSA recognizes product sales when Coherentsells the Kerastick® and/or the BLU-U® to the end-user,as the price is fixed and final at that point. Product sales through ourCanadian distributor for the three and nine months ended September 30, 2004included Kerastick® units of 1,326 and 3,234, respectively, andBLU-U® units placed of 25 and 86, respectively.  Kerastick® sales by Coherentduring the quarter ended September 30, 2004 decreased as compared to theprior quarter as the initial launch sales of 1,908 during the second quarter of2004 included built up demand as a result of DUSA receiving marketing approvalin Canada.  It is anticipated that fourthquarter sales will increase over those seen in the third quarter.**

 

The increaseof Kerastick® and BLU-U® sales in the United States is aresult of the efforts of our sales force, which we launched in October 2003,and related marketing and sales

 

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activities. In addition, theincrease in BLU-U® placements is caused, in part, by our ability to sell theBLU-U® to physicians as a stand alone device for the treatment of moderateinflammatory acne vulgaris following FDA clearance in September 2003. BLU-U®sales during the quarter ended September 30, 2004 decreased, as expected, ascompared with the prior quarter due to a planned price increase that becameeffective at the beginning of the current quarter, and a decreased emphasis onBLU-U® placements by our sales-force, in light of our shrinking BLU-U inventorylevels. We have now ordered additional BLU-U® units, and expect to bere-supplied during the quarter ended March 31, 2005. As we expect to experiencea backlog until the new supply of light sources is available, BLU-U® revenuesare expected to be limited. In addition, growth of Kerastick® units could beadversely affected by limited BLU-U® sales, though we believe this effectshould not be significant.

 

**As expected, due to the potential for electivedermatological procedures to decline during the summer months, sales for thethird quarter of 2004 did not increase at the same rate as compared to therates during the last three quarters. However, product sales to new customersand the results of adding additional sales representatives did offset some ofthe effects of this seasonal fluctuation. Due to the increased number of sales representatives and the increasingacceptance of our therapy, we do expect that sales levels will increase duringthe fourth quarter of 2004 and into 2005.  See “Results of Operations-Marketing and Sales Costs”.**

** **

**Although the level of Kerastick® sales toend-users for 2004 is substantially higher than the level in the prior year,Kerastick® sales must continue to increase significantly in orderfor DUSA to become profitable.  To reachthat goal, we have increased our sales force’s numbers and geographic reach,and we will continue to participate in medical conferences.**

** **

***Cost of Product Sales andRoyalties****–* Cost ofproduct sales and royalties for the three and nine months ended September 30,2004 were $718,000 and $2,613,000, respectively, as compared to $887,000 and$2,465,000 in the comparable 2003 periods. A summary of the components of cost of product sales and royalties isprovided below:

 
| **Three  Months Ended September 30,** | ** ** | ** ** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------------|------------|------------|------------|--------------------------------------|------------|
| **2004**                              | ** ** | **2003**   | ** ** | **Increase  (Decrease)**             | ** ** | ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **Increase  (Decrease)** | ** ** |
| **(Unaudited)**                       | ** ** | ** ** | ** ** | **(Unaudited)**                      | ** ** |
| $                                     | 54,000     |       | $          | 781,000                              |       | $ | (727,000 | ) | Product costs including internal costs  (e.g. customer service, quality assurance, purchasing, depreciation,  amortization and other product support operations) assigned to support  products (1) |   | $ | 754,000 |   | $ | 2,133,000 |   | $ | (1,379,000 | ) |
|                                  |       |       |       |                                 |       |   |   |   |   |   |   |   |   |
| 390,000                               |       | 37,000     |       | 353,000                              |       | Kerastick® product costs |   | 969,000 |   | 109,000 |   | 860,000 |   |
|                                  |       |       |       |                                 |       |   |   |   |   |   |   |   |   |
| 199,000                               |       | 51,000     |       | 148,000                              |       | Costs incurred to ship, install and service  the BLU-U® in physicians offices (2) |   | 715,000 |   | 169,000 |   | 546,000 |   |
|                                  |       |       |       |                                 |       |   |   |   |   |   |   |   |   |
| 75,000                                |       | 18,000     |       | 57,000                               |       | Royalty and supply fees (3) |   | 175,000 |   | 54,000 |   | 121,000 |   |
|                                  |       |       |       |                                 |       |   |   |   |   |   |   |   |   |
| $                                     | 718,000    |       | $          | 887,000                              |       | $ | (169,000 | ) | Total cost of product sales and royalties |   | $ | 2,613,000 |   | $ | 2,465,000 |   | $ | 148,000 |   |

 

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(1)          The decrease in productcosts for 2004 primarily reflects the capitalization of labor and overheadassociated with the start of Kerastick® production in our facility.These costs were expensed in the prior year due to the absence of production.

 

(2)          Although there weredirect BLU-U® product sales in 2004, there were no related directBLU-U® product costs as these units had a zero book value due toinventory impairment charges recorded during 2002.

 

(3)          Royalty and supply feesinclude fees paid to our licensor, PARTEQ Research and Development Innovations,the licensing arm of Queen’s University, Kingston, Ontario, and in 2004amortization of an upfront fee and a royalty paid to Draxis, DUSA’s formerparent, on sales of the Levulan® Kerastick® in Canada.

 

***Research and Development Costs****–*Research and development costs for the three and ninemonth periods ended September 30, 2004 were $1,585,000 and $4,850,000,respectively, as compared to $1,202,000 and $4,167,000 in the same periods in2003.  These increases reflect thepreparation work associated with initiating the Phase II photodamaged skintrial, protocol finalization for our acne trial, and the start of our Phase IIpilot study for Barrett’s esophagus offset, in part, by lower third-partyexpenditures for our FDA mandated Phase IV clinical study of the long-termefficacy of the Kerastick®. This FDA mandated Phase IV study wascompleted in late 2003 and we incurred only limited costs to file the finalreport with the FDA in 2004. We have concentrated our dermatology developmentprogram on indications that use our approved Kerastick®. Based onmarket research that was completed in 2003, we have moved forward with ourPhase II clinical studies for use of Levulan® PDT in photodamagedskin and moderate to severe acne vulgaris. We initiated the photodamaged skinstudy during the second quarter of 2004, and a Phase II study on Levulan**®** PDT for the treatment of acnevulgaris at the end of October 2004. In addition, the current nine month periodincludes compensation of $241,000 for 30,000 fully vested stock options issuedto three consultants for services. We expect to incur total research anddevelopment costs of approximately $6,500,000 to $7,500,000 during 2004 dueprimarily to initiating these studies.

 

DUSA has also been following patients who completedPhase I/II studies in the treatment of high-grade and low-grade dysplasiaassociated with Barrett’s esophagus. On September 27, 2004 DUSA signed aclinical trial agreement with the National Cancer Institute, Division of CancerPrevention, or NCI DCP, for the clinical development of Levulan® PDTfor the treatment of high-grade dysplasia within Barrett’s Esophagus.  In addition, to further our objectivesconcerning treatment of internal indications using Levulan®photodynamic therapy (“PDT”), on November 4, 2004 we signed an additionalclinical trial agreement with the NCI DCP for the treatment of oral cavitydysplasia. DUSA and the NCI DCP will be working together to prepare overallclinical development plans for Levulan® PDT in these indications,starting with 

 

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Phase II trials, and continuing through Phase IIIstudies, if appropriate. The immediate plan is for the NCI DCP to solicitclinical protocols from its extramural expert clinical investigator consortium,after which time DUSA and the NCI DCP will finalize the clinical trial designs.The NCI DCP will use its resources to file its own Investigational New Drugapplications with the FDA. DUSA will provide Levulan®, device(s) andthe necessary training for the investigators involved in the studies, and is inthe process of estimating DUSA’s incremental costs of this program. DUSA willmaintain full ownership of its existing intellectual property, has options onnew intellectual property and, subject to successful Phase II and III clinicaltrial results, intends to seek FDA approvals in due course. In preparation fornew Phase II clinical trials for the treatment of high-grade dysplasiaassociated Barrett’s esophagus, we have initiated a small single-center pilotPhase II clinical trial using DUSA’s new proprietary endoscopic light deliverydevice.

 

***Marketing and Sales Costs****–* Marketing and sales costs for the three and nine monthperiods ended September 30, 2004 were $1,835,000 and $4,902,000, respectively,as compared to $535,000 and $1,599,000 in the comparable periods in 2003. Thesecosts consist of overhead expenses such as salaries and benefits for themarketing and sales staff, commissions, and related support expenses such astravel, and telephone, totaling $1,438,000 and $3,731,000 for the three andnine month periods ended September 30, 2004, respectively, as compared to$233,000 and $600,000 in 2003. The remaining expenses consist of tradeshows,miscellaneous marketing and outside consultants totaling $397,000 and$1,171,000 for the three and nine month periods ended September 30, 2004,respectively, as compared to $302,000 and $999,000 in 2003.  These increases were mainly attributable tothe launch of our direct sales force in October 2003 and related marketing andsales activities.

 

As of September 30, 2004, our sales force wascomprised of 22 direct representatives and various independent representativesin key target markets. We anticipate that the level of marketing and salesexpenses will remain relatively stable for the balance of 2004 as we do notplan to significantly expand our sales force any further at this point in time.

 

***General and Administrative Costs****–*General and administrative costs for the three and ninemonth periods ended September 30, 2004 were $1,198,000 and $5,776,000,respectively, as compared to $1,627,000 and $4,782,000 in the comparableperiods in 2003.  The decrease in thecurrent three month period is due mainly to lower legal expenses of $291,000 in2004, as compared to $814,000 in 2003 due to the absence of patent litigationcosts in Australia as the final hearing in the PhotoCure litigation was held inApril 2004.  The increase in the currentnine month period is mainly attributable to legal expenses amounting to$2,822,000 during 2004, as compared to $2,400,000 in the comparable 2003period, due to higher patent litigation costs primarily associated with thefinal hearing in Australia earlier in 2004.

 

In April 2002,PhotoCure ASA filed suit against Queen’s University at Kingston, Ontario,alleging that Australian Patent No. 624985, which is one of the patentslicensed by PARTEQ to us, relating to ALA technology, was invalid.  As a consequence of that action,

 

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Queen’s University assigned theAustralian patent to us so that we could participate directly in thislitigation.  We filed an answer settingforth our defenses and a related countersuit alleging that certain activitiesof PhotoCure and its marketing partner, Galderma S.A., infringe the patent. Thefinal hearing in the Federal Court of Australia was held in April 2004, and weexpect that the Court’s decision will be rendered in late 2004 or early2005.  We are unable to predict theoutcome at this time. However, should PhotoCure prevail in either part of thecase, i.e. the Court finds that (i) our patent is invalid, or (ii) the patentis valid, but PhotoCure’s product does not infringe the patent, PhotoCure willbe able to market its product in Australia. Each party has the right to appeal within approximately one month of theCourt’s decision. In August 2004, DUSA, PhotoCure and Galderma entered into aMediation Agreement designed to facilitate resolution of the parties’ potentialpatent disputes concerning PhotoCure and Galderma’s methyl aminolevulinateproduct. The parties’ discussions are on-going.

 

In December 2003, DUSA was served with a complaintfiled in the State of Michigan Circuit Court for the County of Oakland allegingthat DUSA’s BLU-U® caused the plaintiff to suffer a seizure duringthe performance of her duties as an office assistant. The complaint namesBerlex Laboratories, Inc., a subsidiary of our former marketing partner, asanother defendant. The damages are unspecified. The case has been removed tothe U.S. District Court, Eastern District of Michigan, Southern Division. Wehave filed our answer denying the claims. Berlex has requested indemnification from DUSA under the terms of theCompany’s former agreement with Schering AG, Berlex’s parent. Currently, DUSAhas declined to indemnify Berlex. Recently the Court entered an order allowingthe Plaintiff’s attorney to withdraw. Plaintiff is currently acting on her ownbehalf. A Motion to Dismiss for No Progress is scheduled for hearing onNovember 22, 2004. While it is not possible to predict or determine the outcomeof this action, we believe that the costs associated with all such matters willnot have a material adverse effect on its consolidated financial position orliquidity but could possibly be material to the consolidated results ofoperations in any one period to the extent costs are not covered by DUSA’sinsurance.

 

***Other Income, net*****– Other income for the three and nine month periods endedSeptember 30, 2004 was $351,000 and $1,125,000, respectively, as compared to$409,000 and $1,502,000 in the comparable 2003 periods.  These decreases were attributable to areduction in our average investable cash balances during 2003 and early 2004,as we used cash to support our operating activities.  With the addition of the proceeds from theprivate placement in March 2004, interest income will be impacted by thedirection of interest rates and as our investable cash balances are used tosupport our operating activities. During the nine month period ended September30, 2004, we incurred interest expense of $20,000 on borrowings associated withthe construction of our Kerastick® manufacturing facility ascompared to $45,000 in the comparable 2003 period, of which $36,000 wascapitalized in property and equipment in the Condensed Consolidated BalanceSheet as of September 30, 2003.  DUSArepaid the outstanding secured term loan promissory note with Citizens Bank ofMassachusetts in June 2004.

 

***Net Losses*****– For the three and nine months ended September 30, 2004,the Company incurred net losses of $2,975,000, or $0.18 per share, and$11,573,000, or $0.72 per share,

 

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respectively, as compared to net losses of $3,680,000,or $0.26 per share, and $11,057,000, or $0.79 per share for the comparableperiods in 2003.  Net losses are expectedto continue until product sales to physicians offset the cost of our salesforce and marketing initiatives, and the costs for other business supportfunctions.

 

# **Liquidityand Capital Resources**

# ** **

DUSA is in astrong cash position to continue to fund increased Levulan® PDTsales and marketing expenses and current research and development activitiesfor its Levulan® PDT/PD platform. At September 30, 2004, we had approximately $52,545,000 of total cashresources comprised of $10,493,000 of cash and cash equivalents, marketablesecurities available for sale totaling $41,912,000, and restricted cash of$140,000. As of September 30, 2004, these securities had yields ranging from1.25% to 7.63% and maturity dates ranging from October 15, 2004 to February 15,2007.   In August 2004, DUSA changed itsinvestment policy to allow investment of a portion of its securities in highgrade corporate bonds in order to improve yields earned on its marketablesecurities.

 

On February27, 2004, DUSA completed a private placement of 2,250,000 shares of its commonstock at a purchase price of $11.00 per share resulting in gross proceeds of$24,750,000. We also granted the investors the right to purchase up to anaggregate of an additional 337,500 shares of common stock at $11.00 per share,which were exercised on April 14, 2004, resulting in additional proceeds of$3,712,500. Offering costs incurred in connection with the placement were$1,908,000, of which $1,708,000 consisted of the placement agent’s commissionand non-refundable retainer paid in the form of 155,250 shares of common stockcalculated at the offering price.

 

As of September 30, 2004, working capital (totalcurrent assets minus total current liabilities) was $53,326,000 as compared to$33,838,000 as of December 31, 2003. Total current assets increased $19,310,000 in 2004 due primarily to the grossproceeds received from the private placement of $28,463,000, offset by the useof $11,441,000 of cash and cash equivalents to support our operatingactivities.

 

As of September30, 2004, DUSA had current liabilities of $3,040,000, as compared to $3,218,000as of December 31, 2003.   This decreaseis due in part to the repayment of debt in June 2004 with proceeds from theprivate placement.  In May 2002, weentered into a secured term loan promissory note (“Note”) with Citizens Bank ofMassachusetts to fund the construction of our manufacturing facility andborrowed $1,900,000. DUSA repaid the outstanding loan balance in June 2004.

 

We believethat we have sufficient capital resources to proceed with our current programsfor Levulan® PDT and to fund operations and capital expenditures forthe foreseeable future.  We have investedour funds in liquid investments so that we will have ready access to these cashreserves for funding our needs on a short-term and long-term basis.

 

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DUSA may alsoseek to expand or enhance its business by using resources to acquirebusinesses, new technologies, or products, especially in dermatology-relatedareas. For the remainder of 2004, we are focusing primarily on increasing salesof the Levulan® Kerastick®.

 

DUSA has no off-balance sheet financing arrangementsother than its operating leases.

 

# **ContractualObligations and Other Commercial Commitments**

# ** **

In May 2002,DUSA entered into a secured term loan promissory note (“Note”) with CitizensBank of Massachusetts to fund the construction of its manufacturing facilityand borrowed $1,900,000. DUSA repaid the outstanding loan balance in June 2004.The security interest in approximately $3,000,000 of our United Statesgovernment securities that were being pledged as collateral to secure the loanwas released.

 

DUSA includeda summary of our Contractual Obligations and Other Commercial Commitments inour annual report on Form 10-K for the year ended December 31, 2003. There havebeen no material changes to the summary provided in that report other than thatnoted above.

 

# **RecentlyIssued Accounting Pronouncements**

# ** **

The Companyhas reviewed the latest accounting pronouncement and does not believe any newstandard will have a material impact on the Company’s financial position oroperating results other than those presented in our Annual Report on Form 10-Kfor the year ended December 31, 2003.

 

# **Inflation**

# ** **

Althoughinflation rates have been comparatively low in recent years, inflation isexpected to apply upward pressure on our operating costs.  We have included an inflation factor in ourcost estimates.  However, the overall neteffect of inflation on our operations is expected to be minimal.

 

**ITEM 3.**                                                     QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

DUSA holdsfixed income marketable securities that are subject to interest rate marketrisks. However, we do not believe that the risk is material as we make ourinvestments in relatively short-term instruments and we strive to match thematurity dates of these instruments to our cash flow needs. A ten percentdecline in the average yield of these instruments would not have a materialeffect on our results of operations or cash flows.

 

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**ITEM 4.****                                                     CONTROLSAND PROCEDURES**

 

DUSA carriedout an evaluation, under the direction of its Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of itsdisclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)and 15d-15(e)). Based upon that evaluation, the Chief Executive Officer andChief Financial Officer concluded that our disclosure controls and procedureswere effective as of September 30, 2004.

 

There havebeen no changes in our internal control over financial reporting that occurredduring the quarter ended September 30, 2004 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

**Forward-Looking Statements**

 

This report,including the Management’s Discussion and Analysis, contains various“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933 which represent our expectations or beliefs concerningfuture events, including, but not limited to statements regarding management’sgoal of becoming profitable, beliefs regarding adoption of our therapy,improving reimbursement levels, marketing costs, expectations for research anddevelopment costs, continuing operating losses, increasing sales levels andparticipation in medical conferences, expectations of increasing staff andhiring levels for our sales force, plans with respect to the NCI DCP clinical trialsand anticipated commitment of resources, maintenance of intellectual property,and intentions for seeking regulatory approvals, timing of Phase II acnestudies, effects of unanticipated changes in estimates, technology andforecasts, belief concerning reasonableness of inventory levels, factors whichcould trigger impairment review, effect of an accounting change for stock-basedcompensation, expectations for the use of our facility to manufactureKerasticks® and other clinical supplies, plans to conduct additionalclinical trials for high-grade dysplasia, expectations for timing of receipt ofBLU-U inventory and impact on revenues from a potential backlog, management’suse of proceeds from the sale of securities, and consummation of any marketingand sales partnerships, expectations for increased marketing and sales costsand levels of legal fees, beliefs regarding the Australian patent litigationand Michigan product litigation, expectations regarding levels of interestincome and net losses, requirements of cash resources, and potential impact onconversion of government securities, need for additional funds for development,intentions to expand or enhance business through acquisition, new technology ornew products, evaluation of transactions under new accounting pronouncements,inflation, market risks and controls and procedures. These forward-lookingstatements are further qualified by important factors that could cause actualresults to differ materially from those in the forward-looking statements.  These factors include, without limitation,changing market and regulatory conditions, actual clinical results of ourtrials, the impact of competitive products and pricing, the FDA approval andmarket acceptance of our products, the maintenance of our patent portfolio andability to obtain competitive levels of reimbursement by additional third-partypayors, and

 

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other risks noted in our SECfilings from time to time, including our Form 10-K for the period endingDecember 31, 2003, none of which can be assured.

 

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# **PART II- OTHERINFORMATION**

# ** **

Items 1, 3, and 5.

 

None.

 

Item 2.    Changesin Securities and Use of Proceeds.

 

i)                         February2004 Private Placement – On February 27, 2004, DUSA entered into definitiveagreements with certain new and existing institutional and other accreditedinvestors for the private placement of 2,250,000 shares of our common stock ata purchase price of $11.00 per share resulting in gross proceeds to DUSA of$24,750,000. DUSA granted the investors the right to purchase up to anaggregate of an additional 337,500 shares of common stock at $11.00 per sharewhich were exercised on April 14, 2004. Offering costs incurred in connection withthe placement were $1,907,952, of which $1,707,750 consisted of the placementagent’s commission and non-refundable retainer paid in the form of 155,250shares of common stock calculated at the offering price.  DUSA relied on Rule 506 promulgated under theSecurities Act of 1933 in selling these shares. DUSA engaged in due diligence to confirm that all purchasers of thecommon stock were accredited investors.

 

**DUSA will usethe proceeds from the sale of the securities to expand its sales force and forgeneral working capital purposes, including research and developmentactivities.**

 

Item 6.             Exhibitsand Reports on Form 8-K.

 

i)                 Exhibits

 

a)              Exhibit 31(a) - Rule 13a-14(a)/15d-14(a)Certification of the Chief Executive Officer.

 

b)             Exhibit 31(b) - Rule 13a-14(a)/15d-14(a)Certification of the Chief Financial Officer.

 

c)              Exhibit 32(a) - Certification of theChief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002; and

 

d)             Exhibit 32(b) - Certification of the ChiefFinancial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002.

 

e)              Exhibit 99(a) - Press Release datedNovember 11, 2004

 

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ii)              Form 8-K

 

a)              Form 8-K, dated and filed July 12, 2004,reporting sales results for the quarter ended June 30, 2004.

 

b)             Form 8-K, dated August 17, 2004 and filedAugust 18, 2004, reporting that DUSA, Queens University at Kingston, GaldermaS.A., and PhotoCure ASA have entered into a Mediation Agreement designed tofacilitate resolution of the parties’ potential patent disputes concerningPhotoCure and Galderma’s methyl aminolevulinate product.

 

c)              Form 8-K, dated August 20, 2004 and filedAugust 26, 2004, reporting that Peter Chakoutis, DUSA’s Chief Financial Officerand principal financial officer, has resigned for personal reasons. The partiesexpect the resignation to be effective on December 31, 2004 and Mr. Chakoutishas offered to remain in his position on a part-time basis from January 1, 2005through March 31, 2005 should the Registrant require his services.

 

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**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
|   | DUSA  Pharmaceuticals, Inc. |
|--------|-----------------------------|
|   |                        |   |
|   | By:                         |   /s/  D. Geoffrey Shulman |   |
|   |                        | D. Geoffrey  Shulman |
|   |                        | President  and Chief Executive Officer |
|   |                        | (principal  executive officer) |
|   |                        |   |
| Date:  | November 11,  2004          |   | By: |   /s/  Peter M. Chakoutis |   |
|   |                        | Peter M.  Chakoutis |
|   |                        | Vice  President and Chief Financial  Officer (principal financial officer) and  Controller (principal accounting officer) |
|        |                             |  |  |  |  |

 

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**EXHIBIT INDEX**

 
| 31(a)  |   | Rule  13a-14(a)/15d-14(a) Certification of the Chief Executive Officer.                                                                                      |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                         |
| 31(b)  |   | Rule  13a-14(a)/15d-14(a) Certification of the Chief Financial Officer.                                                                                      |
|   |   |                                                                                                                                                         |
| 32(a)  |   | Certification  of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002; and |
|   |   |                                                                                                                                                         |
| 32(b)  |   | Certification  of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.     |
|   |   |                                                                                                                                                         |
| 99(a)  |   | Press  Release dated November 11, 2004                                                                                                                       |

 

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